Canadian Dollar Drops Most Since 2011 on Surprise Cut

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Canada’s dollar sank the most in more than three years after the central bank unexpectedly cut interest rates, saying crude oil’s collapse will slow inflation and weigh on the economy.

The currency reached the weakest level in almost six years after the Bank of Canada reduced economic forecasts and lowered the benchmark rate target to 0.75 percent, from 1 percent, where it’s been since 2010. Government bonds climbed, pushing yields on two-, 10- and 30-year debt to record lows. Crude, Canada’s biggest export, has tumbled more than 50 percent since June amid a global glut.

“They are taking pre-emptive steps,” Thomas Costerg, an economist at Standard Chartered Bank, said in a phone interview from New York. “If oil prices remain under pressure, you could potentially see further cuts. This was not expected, and it’s going to put pressure on the loonie.”

The currency, nicknamed the loonie for the image of the aquatic bird on the C$1 coin, depreciated 1.8 percent to C$1.2340 per U.S. dollar at 5 p.m. Toronto time. It slid as much as 2.3 percent, the most since September 2011, to C$1.2394, the weakest level since April 2009. One Canadian dollar buys 81.04 U.S. cents.

BOC Governor Stephen Poloz said at a press conference the central bank “has room to maneuver should its forecast prove to be either too pessimistic or too optimistic.”

Contraction Risk

Another rate cut wouldn’t surprise Aubrey Basdeo, head of Canadian fixed-income at BlackRock Inc., as the Bank of Canada tries to cushion sputtering growth.

“The oil-price shock is going to be pretty disastrous for the Canadian economy, at least initially,” Basdeo said by phone from Toronto. “Growth could atrophy in a bigger way than the Bank of Canada is predicting. There’s a risk of contraction in the first half of the year.”

The yield on Canada’s benchmark 10-year bond dropped to as low as 1.365 percent before trading at 1.43 percent, 0.44 percentage point below the U.S. 10-year note yield. It’s the biggest difference since 2007.

Yields on Canadian two-year securities touched 0.536 percent, and 30-year bond yields reached 2 percent.

None of the 22 economists in a Bloomberg News survey predicted the cut. The interest rate, which influences everything from car loans to mortgages, had been unchanged since September 2010. The last reduction was in April 2009.

‘Big Shock’

“It’s a big shock,” David Doyle, a strategist at Macquarie Capital Markets, said by phone from Toronto. “They’re going to try to provide the necessary medicine here for the soft landing from slowing debt growth, from slowing investment in the oil sands.”

The Bank of Canada reduced its growth forecast for the first half of this year to a 1.5 percent annualized pace, from an October estimate of 2.4 percent. Inflation will slow to 0.3 percent in the second quarter, outside the central bank’s target range of 1 percent to 3 percent, the bank projected.

The central bank said the nation’s economic recovery will be delayed until the end of next year.

“You’re buying insurance,” Andrew Kelvin, senior fixed income strategist at Toronto-Dominion Bank, said by phone from Toronto. “You’re insuring against the possibility the disinflationary impulse of lower oil prices are more persistent than you expect, and you’re insuring against a larger-than-expected drag on the Canadian economy.”

Volatility Jumps

The rate decision pushed realized volatility on the loonie to the highest level in more than three years. The 14-day average true range of the currency, a volatility gauge that takes into account the differences between intraday highs and lows, rose to 0.013, the highest since November 2011.

The BOC’s move followed a rate cut by the Danish central bank this week and a surprise announcement Jan. 15 by the Swiss National Bank that it was ending a three-year-old cap on the franc versus the euro. The decisions came before the European Central Bank meets Thursday amid speculation it will decide to purchase sovereign bonds in an effort to head off deflation.

“You look back to the Swiss National Bank, and maybe that’s the status quo for central banks, they are going to want to shock the market,” said Ken Wills, currency strategist at CanadianForex based in Toronto.

A further drop in oil may produce lower Canadian interest rates, Wills said.

‘Structural Break’

Goldman Sachs Group Inc. said it’s reviewing the forecast for the Canadian currency. The bank lowered its six-month projection to C$1.20 from C$1.14 at the beginning of January.

“The big picture is that this represents a structural break for the BOC, with policy diverging from our expectations for the Fed,” Robin Brooks, a chief currency strategist at Goldman, said in a research note.

There’s a 67 percent chance the Federal Reserve will raise its benchmark rate for the first time since 2006 by December, futures trading showed. The rate has been in a range of zero to

0.25 percent since 2008.

Canada, the Group of Seven’s biggest crude exporter, is already feeling the effects of crude oil dropping below $50 a barrel, as companies such as Calgary-based Suncor Energy Inc. reduce staffing and investment. Canada’s oil sands are among the most expensive reserves to develop.

Crude traded at $47.36 a barrel in New York, after reaching a 2014 high of $107.73 in June.

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